The franchise model of doing business streamlines the entrepreneurial process.
By Nellie Akalp
The franchise model of doing business streamlines the entrepreneurial process. By working as a franchisee, you can become a business owner without much of the prep work required to build a company’s infrastructure and systems from scratch.
But even though a franchise location is associated with a larger brand, the owners are responsible for forming a business entity and managing all operations and administration at their location.
In this article, I will discuss some of the nuances of starting and operating a franchise entity.
Franchise vs Franchisor: What’s the Difference?
First, let’s clarify some of the terminology I’ll be referring to in this post:
- What is a franchisor? A franchisor is a company that sells the right to others to open stores or sell products or services using its brand, expertise and intellectual property.
- What is a Franchisee? A franchisee is a person or business entity licensed to operate their private business (a franchise) under an agreement with a franchisor.
For example, McDonald’s is one franchisor; the owner of the McDonald’s branch in your city is a franchisee.
Franchising and formation of a business entity
Forming a legal business entity provides liability protection to business owners and can provide some tax benefits. The underlying purpose for setting up a franchisor’s entity is slightly different than why it is important to set up an entity for a franchise location.
franchisor entity
A franchisor forms an entity to sell rights to franchisees to open and operate a franchise location using the franchisor’s brand, intellectual property, and expertise. As an independent legal and accounting entity, the franchisor protects its owners and main business against the debts and legal obligations of franchisees.
Consider this hypothetical example: Subway is a franchisor. Suppose someone wants to sue the company after slipping and falling on a wet floor at a franchisee’s location. The individual would sue the local franchise company and the main franchise entity would be protected.
Franchisors often choose the Limited Liability Company structure for their entity. Technically, a franchisor can be formed in any state. However, it is wise for franchisors to discuss their options with an attorney and tax advisor before making a decision.
Franchisee entity
A franchisee is an entity created by a franchisee upon purchasing the rights to operate a local franchise. Many franchisors will require the franchisee to establish their entity before drafting contracts or a Franchise Disclosure Document (FDD) so that the paperwork can be put in the name of the entity. Franchisee entities are usually LLCs. Many franchisors will not allow a company to buy a franchise because the issuance of stock would have significant legal and tax implications.
A franchisee almost always must register its entity in the state where it has a physical presence, regardless of where the owner resides. The physical location of the franchise requires permits, licenses, leases, etc., and therefore the business must be registered in that jurisdiction in order to obtain them.
Naming a Franchise Entity
Many franchisors create an entity under a name that implies the purpose of selling franchises, for example, Your Company Franchising Inc. of Your Company Franchise Sales, Inc. This makes it easy to distinguish entities.
As for franchisees, they are allowed to use the brand name of the franchise for marketing purposes by preparing a DBA (a fictitious name). However, their legal entity name should not include the name of the franchise being purchased (because the franchisor has trademark rights to that entity name).
For example, franchisees would avoid registering their legal entity as Smith Subway, LLC or Smith’s Burger King, but could instead set up DBAs such as “Subway Store #1234” or “Burger King Woodland Hills”. Franchisors usually have a specific way that franchisees must format their DBAs.
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What about multi-unit franchises?
A multi-unit franchise is when a franchisee purchases multiple locations. Typically, the franchisor will want each unit set up as its own separate legal entity with separate DBAs and licenses.
In some cases, franchisees can start a parent company that will keep all of their entities under it to keep things simple. However, this only works if the franchises are all owned by the same people.
Entity Requirements for Franchise Businesses
In addition to contractual obligations to franchisors, franchisees must comply with federal, state, and local requirements when setting up their business entity:
- File formation paperwork with the state to form the LLC or corporation.
- Provide an EIN (employer identification number).
- File a DBA (doing business as) to establish a fictitious name for the franchise location.
- Create an LLC business agreement (or company bylaws).
- Register for payroll tax and other employment-related taxes.
- Full VAT registration (usually not applicable to service based franchises).
- Submitting all required business licenses and permits to legally operate in their location.
Become a franchisee
Are you curious about what is involved in starting and running a franchise? Here are resources that can help you assess feasibility and explore the possibilities:
Starting a franchise business allows you to enter the world of entrepreneurship with built-in brand awareness and established systems and processes. That doesn’t mean it’s all “plug and play” though! Make sure you get the legal and accounting guidance you need to make sure it’s the right choice for you.
About the author
Nellie Akalp is a passionate entrepreneur, business expert, professional speaker, author and mother of four. She is the founder and CEO of CorpNet. coma trusted resource and service provider for business formation, LLC filings and business compliance services in all 50 states.
